Question

QUESTION 22 Modigliani and Miller's Irrelevance Hypothesis assumes that there are no taxes, no costs of financial distress, no symmetrie information between investors and corporate executives, te. When the assumptions are relaxed so that they are more consistent with the real world there are corpore taxes and interest payments are tax deductible) and there we costs of financial distresses which of the following is true? Each firm has an optimal capital structure where WACC is maximized Each firm has an optimal capital structure where firm value is minimized Firm value increases and WACC desresses initially as more debt is added to the firm's capital structure, however, there comes a point where adding additional del generates potential costs of financial distress that outweigh the benefits of further reducing taxes. After this point, firm value starts to decrease and WACC starts to increase a more debt is added Firm value and WACC are independent of the firm's capital structure Firm value increases and WACC increases initially as more debt is added to the firm's capital structure, however, there comes a point where adding additional debt generates potential costs of financial distress that outweigh the benefits of further reducing taxes. After this point, firm value and WACC start to decrease as more debt is added.

Answer 1

In case of presence of debt the WACC decrease intitally as the debt increases which eventually lead to increase in value of firm but after a point the WACC is start incresaing due to presence of higher debt which lead to financial distress which eventually lead to decrease in value of firm. Thus the only statement which is true is the 3rd option.